11A trend is an ephemeral and capricious thing, prone to conditions that the human mind hasn’t yet developed far enough to perfectly comprehend. We’ll never be able to forecast the machinations of the market with 100% accuracy, but that hasn’t discouraged some intrepid stock analysts from trying to close the gap. One tool built for that purpose is the Aroon oscillator, which might not catch trends before they happen, but does measure their direction and strength.

Among technical analysis metrics, the Aroon oscillator is simpler than most. So much so that it’s somewhat surprising that no one thought of it before Tushar Chande, the Pittsburgh-based analyst who devised the oscillator in 1995. “Aroon” is a Sanskrit word loosely translated as the transition from night to day, appropriate for a measure that attempts to determine when a trend is about to develop into something of substance.

Like most technical indicators, the Aroon oscillator measures movements over a fixed period of days. Theoretically, the number of days could be arbitrary, but convention dictates using 10 or 25. We’ll use 10, to make the calculations easier. We begin by determining the highest and lowest levels the stock (or currency, or index, or whatever) in question reached during those 10 days. Counting from the start of the period, we want to know the number of days it took to reach each extreme.

So if a stock was trading at $20 on Day 1, reached a peak of $25 on Day 2, and then bottomed out at $16 on Day 8, we’d be interested in Days 2 and 8. We divide into the number of days, then express that quotient as a percentage, giving us 20 for the “Aroon Up” and 80 for the “Aroon Down.” If either is greater than 70 – in other words, if the underlying security traded at a higher (or lower) price in the last three days than it did in the previous seven – that’s supposed to mean a trend in that particular direction. Both intermediate measurements, the Aroon Up and Aroon Down have their own distinct merits and uses for traders. The former is supposed to measure the strength and viability of any uptrend in the market; the latter, unsurprisingly, any downtrend. Some traders use will use one or the other exclusively.

The Aroon oscillator combines the Aroon Up and Aroon Down into a single value as it moves, or oscillates, between the two. The oscillator has a formula that requires some arithmetic dexterity. We’ll walk you through the formula here with, hopefully, a minimum of confusion.

You subtract the Aroon Down from the Aroon Up. That’s it.

For instance, in the 10-day period from February 24 to March 7, 2014, the Irvin, Texas-based Exxon Mobil Corp. (NYSE:XOM) opened at 96.44 and closed at 94.99. The stock reached a zenith of 96.52 on Day 7, and a nadir of 93.76 on Day 9. That’s an Aroon oscillator value of -20, signifying a small downward trend. Ardent technical analysts will view a static value as being of negligible worth on its own, and will track the Aroon oscillator daily, making adjustments accordingly.

So, what to do with this information? For some, everything is contingent first on whether the Aroon oscillator is positive or negative, and second on when (and whether) the oscillator crosses over. Once the oscillator’s sign switches from + to –, that’s interpreted as an indication to sell, and of course the opposite movement is therefore an indication to buy. All things being equal, the longer the period for which the Aroon oscillator is calculated, the less variation it’ll show. Traders looking to capitalize in the short term, beholden to a 10- or 25-day period, will see the oscillator cross zero more often than will position traders who calculate the oscillator over as long a period as 2 to 3 months. Choose the wrong duration for your purposes, and you’ll end up with an Aroon oscillator either too sensitive or too languid.

It’s critical to remember that the Aroon oscillator is, ultimately, a lagging indicator. It’s supposed to unearth and/or confirm an existing trend, not predict one. The window for capitalizing on that trend, before the rest of the buyers and sellers discover it and information thus floods the marketplace, is necessarily a narrow one.

The Bottom Line

Like any other technical analysis tool, the Aroon oscillator doesn’t attempt to distill wisdom from cold accounting data, such as a company’s cost of goods sold or its net receivables. Instead, the oscillator’s value derives from its ability to gauge what buyers and sellers in the market are doing, and are expected to do, in totality. If the Aroon oscillator can measure those traders’ sentiments faithfully, it should be able to reward the analyst who knows how to apply it.

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